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Buried in the Fed minutes is another downgrade to the U.S. economy

MARKETWATCH 10:56 AM ET 10/9/2015


Minutes show that the Fed's staff has further cut economic estimates

A goal of a 4% economy? That objective, mentioned frequently in the 2016 presidential race, is getting farther away, according to the latest projections from the staff of the Federal Reserve.

Minutes of the Fed's Sept. 16-17 policy meeting disclose the Fed staff further trimmed its assumptions for the rates of productivity and potential growth over the medium term. The minutes did not specifically quantify the new forecast of the Fed's in-house economists.

The Fed staff's view was already gloomy. A mistaken leak this summer by the U.S. central bank revealed, going into the Fed's June policy committee meeting, the U.S. central bank's staff penciled in potential growth averaging just 1.74% over 2015-2020, according to the document now on the Fed's website (http://www.federalreserve.gov/newsevents/ press/monetary/20150724a.htm). That's down from an average growth rate of 3.1% over the past 50 years. Ordinarily those forecasts would have been kept secret for five years (http://www.marketwatch.com/story/here-are-the-staff-forecasts- that-the-fed-accidentally-leaked-2015-07-24).

Fed officials -- in other words, the people who get to vote on interest rates -- think the economy can growth a little faster than the staff. They pencil in 2.0% for the economy's long-run growth rate.

Potential growth in the long run is a function of two things: population growth and productivity.

Productivity is the secret sauce of the economy (http://www.marketwatch.com/story/go-go-economy-becomes-so-so-economy- us-faces-dimmer-future-absent-big-fixes-2015-08-04) but it has dropped off sharply since the Great Recession.

Over the last year, productivity has increased by just 0.7%, far below the long-run average of 2.2%.

Why it is falling remains a puzzle.

With trend growth so low, the economy is in a pickle.

Even moderate gross domestic product in the range of 2.0-2.5% that the Fed expects can produce inflation.

"It's a bad place to be," said Robert Brusca, chief economist at FAO Economics.

With low productivity, the Fed is more eager to raise interest rates at low growth rates.

To be sure, not everyone shares this fear. Peter Fisher, senior director at BlackRock Investment Institute, said he doubted that inflation would pick up just because there was a narrowing of the output gap caused by low productivity.

"I, for one, don't think we're going to get a pickup in inflation that is worrisome in an atmosphere where we don't see an acceleration of demand," Fisher said in an interview on Bloomberg Radio.

"Simply narrowing the output gap that takes place just because of a slowdown in productivity I don't think gives up the same kind of inflation pressures as [would] accelerating demand that closes the output gap," he said.

-Greg Robb; 415-439-6400; [e-mail]

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10-09-151056ET
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